Evaluation of Intellectual Capital
Franko Milost
University of Primorska
Slovenia
Intellectual capital represents the most important factor of a business process. However, its value is not shown in a company’s financial statements. The main reasons for this shortcoming are
objective difficulties in determining its value. Determining the
value of intellectual capital is of vital importance when managing
employees. Therefore, financial statements that are omitting the
value of employees cannot represent a true picture of the company’s past operations.
The aim of the paper is to present the basic futures of existing monetary evaluation models of intellectual capital and describe the main futures about the original model developed at the
Economic Institute of the Faculty of Management. First, we compare the basic futures of four most convenient monetary models
which are: capitalization of historical costs model (Likert, ),
discounted wages and salaries model (Lev and Schwartz, ),
replacement costs model (Flamholz, ), and opportunity costs
model (Hekimian and Jones, ). We draw attention to their
main performance disadvantages which are the starting point for
constructing our original monetary model. Their main features
will be described in the second section of the article. We conclude
our analysis with presentations of the explanatory power of our
original monetary model with respect to the selected four monetary models.

Man’s work is an important element of the business process. However,
apart from its role as a means of production, products and services, its
value is not disclosed on the assets side of the classical balance sheet.
Are there any solid grounds for such consideration of work? Does such
consideration of Man’s work result from underestimating the meaning
of this element of the business process? And finally, isn’t work (employees, human potential, intellectual capital) a factor that has a crucial influence on successful business operations? These and similar questions
arise within the scope of Human Resource Accounting.

Franko Milost
Findings on the value of intellectual capital are not new. In fact, its
value has already been well recognised by pre-classical economists who
treated Man as a national treasure. Over time, this knowledge underwent
the process of maturation; nowadays, however, intellectual capital finds
its position in financial statements only exceptionally.
This article identifies the most significant monetary and non-monetary models of intellectual capital evaluation. Additionally, our model of
evaluation (the dynamic model) is presented.
    

Intellectual capital may be disclosed among the assets on a balance sheet
only if it is expressed in value terms. In order to disclose intellectual capital among balance sheet items, one must find a proper method for measuring its value. So far, some monetary and non-monetary models have
been developed for this purpose. Some of the most important models are
outlined below. Additionally, our original (dynamic) monetary model of
intellectual capital evaluation is presented.
Non-Monetary Models for Evaluating Employees
Among the non-monetary models, the Michigan, Flamholz and Ogan
models are presented below. The first two models are purely nonmonetary, whilst the third one is combined, since it includes both monetary and non-monetary methods of evaluation.
The Michigan Model. The very first ideas of a non-monetary evaluation of employees can be traced to works of researchers from the Institute
for Social Research, which operates under the umbrella of the University
of Michigan. The researchers of the Institute shaped the model known as
the Michigan or Likert model (named after the leading researcher of the
Institute). The model defines variables that are likely to influence the effectiveness of individuals in an organisation and, therefore, the successful
operation of a human organisation per se (Likert at al. , ).
The Michigan model aims at indirectly define the value of employees
in an organisation. It does not enable a determination of their initial
value, but rather monitors value changes resulting from changes within
the organisational climate. Despite the aforementioned, and though
there are numerous open questions to which the authors of the Michigan
model have found no suitable answers (i. e. the question of various interpretations of such results), Flamholz is of the opinion that the Michigan
Evaluation of Intellectual Capital
model represents the most successful trial of the non-monetary evaluation of employees in an organisation (Flamholz , ).
The Flamholz Model. Contrary to Likert, Flamholz shaped his nonmonetary model of human resource evaluation in terms of the individual. He wanted to explain factors that influence the value of an individual in an organisation. This model consists of behavioural and economic
variables.
It is based on the assumption that the value of an individual in an
organisation depends on two interrelated variables, namely:
• the individual’s conditional value and
• the probability of maintaining organisational membership.
The individual’s conditional value is determined as ‘the current value
of future services that may be rendered by an individual in an organisation during his/her expected working life’ (Flamholz , ).
Flamholz tested his model by evaluating employees in a company registered for services in the area of accounting and business finances
(Flamholz , –).
The Ogan Model. Similarly to Flamholz, Ogan shaped a model in
which some of the most important variables influencing the value of an
individual in an organisation are defined. The model aims at evaluating
human resources especially in those service enterprises where marketdetermined prices are not in use. Prices of some services, for example, are
determined by professional associations such as bar associations, medical associations etc. This is a combined model since it includes both
monetary and non-monetary measures. The basic idea of the model is
to measure the amount of a company’s long-term benefit from an employee. The value that an employee has for the company should equal the
employee’s long-term benefit resulting from his/her employment. This
long-term benefit is determined by two factors, namely:
• the direct benefit of an employee on the account of his employment,
and
• the certainty of his employment.
The direct benefit of an employee is the sum of all expected benefits
resulting from his employment. Employment certainty indicates the level
of probability that the employment remains permanent. The value of an
employee for the company is obtained by multiplying the values of both
factors (Ogan , ).

Franko Milost
Monetary Models of Intellectual Capital Evaluation

We will present the following monetary models of intellectual capital
evaluation: the replacement costs model, the opportunity costs model,
the discounted wages and salaries model and our dynamic model.
Replacement Costs Model. The replacement costs model was developed
by Flamholz in . The author acknowledges two concepts of replacement costs: individual and positional. Individual replacement costs are
defined as a current sacrifice that is mandatory if one wants to replace an
individual of particular capacity with someone (an individual) or something (a machine) of the same capacity. These costs reflect the value of
an individual for a company.
However, the value of an individual largely depends on his current and
future position in a company (achieved due to his capacity). Flamholz
defines positional replacement costs as those resulting from replacing the
particular mandatory services of each employee in a particular work position (workplace) in a company (Flamholz , ).
The usage of this model is limited. The model requires not only an
evaluation of the amount of costs stemming from replacing an employee
with someone or something, but also an evaluation of the probability
that another employee (or machine) will accomplish the same work. Additionally, evaluating the amount of replacement costs of all employees
is a rather difficult task.
Opportunity Costs Model. The opportunity costs model was developed
by Hekimian and Jones in . This model is composed of the opportunity costs of an employee that reflect the value of an employee shown in
case of using his alternative. Opportunity costs are defined as costs of lost
benefits in a situation when an employee performs another task and/or
as costs resulting from acquisition of the needed employee (Hekimian
and Jones , -). According to this definition, an employee has
a certain value only if he/she is an exceptional resource, namely, when
his/her movement from department  to department  causes a lack of
labour force in department . The main weakness of this model is that
it does not recognise the possibility of acquiring certain work abilities by
employing new people.
Discounted Wages and Salaries Model. The discounted wages and
salaries model was developed by Lev and Schwartz in . According
to this model, the value of intellectual capital is defined as the present
value of anticipated (future) remuneration of employees corrected for
Evaluation of Intellectual Capital
performance ratio. The performance ratio of employees is defined as
the ratio between the company’s rate of return and the average rate of
return in the economy. Positive correction of the present value of anticipated remuneration of employees occurs when a company’s rate of
return is larger than the average rate of return in the economy, and on
the contrary, negative correction of the present value of anticipated remuneration of employees occurs when a company’s rate of return is
lower than the average rate of return in the economy (Lev and Schwartz
). Therefore, the underlying assumption is that the future value of
the employees’ work may be evaluated by the amount of their wages and
salaries.
Dynamic Model for Evaluating Employees. This model is based on the
economic concept of value. According to this model, the value of particular goods depends on the present and future benefits associated with
these goods. This also applies to employees. Therefore, the value of employees depends on the present value of their expected future services.
This definition may apply to an individual as well as to all employees
within a company. Therefore, this model is intended to evaluate:
• individual employees and
• groups of employees (i. e. all employees within a company).
The value of individual employees may be determined directly, while
the value of a group of employees may be determined indirectly, as a
corrected sum of values of individual employees. This model is based on
an approach usually used for evaluating the majority of tangible fixed
assets by recognising some specific features of employees.
Some may find the comparison of tangible fixed assets and employees unsuitable, morally disputable or even offensive. We apologise in advance for any misunderstandings. We treat human resources as assets not
because we would like to underestimate their human characteristics, but
because we would like to emphasise their economic value. It means that
we treat human resources as economic goods.
Evaluating Individual Employees. As was already mentioned above, this
model originally aims at evaluating individual employees. It was also
mentioned that the value of a group of employees may be determined
indirectly as a corrected sum of values of individual employees. Our dynamic model for evaluating individual employees is presented in fig. .
Concepts and other items from the model are explained below.
Purchase Value. The purchase value of tangible fixed assets normally
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Franko Milost
Employee value
Purchase value
of an employee
Value of
Value adjustment
+ investments into −
of an employee
an employee
Employee’s
purchase value
adjustment
+
Value adjustment
of investments
into an employee

Employee’s
purchase value
×
Annual
depreciation rate
of investments
into an employee
Annual
Value of
depreciation rate
investments into ×
of investments
an employee
into an employee
  Dynamic model for evaluating individual employees
equals the investment value associated with their acquisition. It is composed of the purchase price along with costs in relation to customs duties, transport, assembly and similar.
The purchase value of an employee is composed of investments into
an employee before and directly upon his/her arrival at a company. The
company does not necessary participate in all components of these investments. In the context of this evaluation model, the purchase value of
an employee includes three components, namely:
• investments in employee training,
• investments in employee acquisition, and
• employee opportunity costs.
Investments in employee training are associated with acquiring his/her
work capacity. In this context, we talk about investment value associated
with primary school, high school and university education. The investment value associated with training an employee to perform certain tasks
may be defined as the usual investment needed in the process of acquiring his/her work capacity. The investment value associated with training
an employee does not depend on the method of acquiring an employee.
It means that the value of this investment is not subject to change when
equally trained employees are of concern. An assumed value, obtained
Evaluation of Intellectual Capital
from the sum of investments needed for an employee in the process of
acquiring relevant work capacity, may serve as the investment value associated with employee training.
Investments in employee acquisition include:
• investments in job advertisement and
• investments in direct employee acquisition.
Investments in job advertisement are associated with: placing ads for
an available position, interviews, evaluation of candidate suitability etc.
Investments in direct employee acquisition are associated with the medical assessment of an employee, his placement etc.
Opportunity costs are lost benefits resulting from choosing a particular alternative. Employee opportunity costs are an individual’s investments into his/her own knowledge and development. Let’s assume that
we are in the position of employing a university graduate. This is an individual who has successfully accomplished his/her education on all three
levels: primary, secondary and tertiary.
Learning is time consuming (since it is measured in years) and tiresome. However, the results of the lasting efforts put into one’s studies
are not tangible material goods, but acquired knowledge and a diploma.
Therefore, the decision for an education forces the employee to decline
remunerations that would be collected in the case of him/her being employed during the time of study. The lost remunerations of an employee
are, therefore, the opportunity costs that reflect the value of an individual’s investments into his/her knowledge and development. Their value
is low at the primary school level and increases with additional years of
study.
Value Adjustment. The value adjustment of a tangible fixed asset is a
value of a fixed asset that is, via its usage, transferred to business effects.
This value depends on the purchase value of a tangible fixed asset and
its useful life. The value adjustment of an employee is a value transferred
by an employee, via his co-operation in a business process, to business
effects. It may be obtained by calculating the sum of an employee’s purchase value adjustment and the value adjustment of investments into an
employee. The calculation is presented below:
Value adjustment of an employee
= Employee’s purchase value
+ Value adjutment of investments into an employee

Franko Milost
The employee’s purchase value adjustment is obtained by multiplying the employee’s purchase value by his annual depreciation rate. The
calculation is presented below:
Employee’s purchase value adjustment
= Employee’s purchase value
× Employee’s annual depreciation rate

The annual depreciation rate of an employee is obtained by dividing
 by his useful life expressed in years. The useful life of an employee, expressed in years, is the period during which the employee shall render
services to the company. This period depends on the expected presence
of the employee in a business process. However, there is a significant difference between a tangible fixed asset and an employee. If ownership is
considered in the classical way, one may quickly figure out that an employee is not owned, since he/she is free to leave a company. Therefore,
the useful life of an employee is the period during which it is reasonably
expected that the employee shall render services to the company. It is a
period from the present day to the day when an employee quits working for a company because he/she finds employment elsewhere, retires
or similar.
The value adjustment of investments into an employee is obtained by
multiplying the value of investments into an employee by the annual depreciation rate of these investments. The calculation is presented below:
Value adjustment of investments into an employee
= Value of investments into an employee
× Annual depreciation rate of investments into an employee
Investments in employee acquisition include:
• investments in direct assurance of working abilities,
• investments in health and well-being, and
• investments in loyalty to the company.
Investments in direct assurance of an employee’s working abilities are
those that are most profoundly relative to the employee’s work in a company. They include: investments into formal and informal training and
introductory training, a lower productivity of an employee during the
period of his introductory training, and a lower productivity of an employee prior to his leaving the company (the opportunity costs of the
company).
Evaluation of Intellectual Capital
Investments into health and well-being are those that enable regular
attendance in the workplace. They include: periodic employee medical
check-ups, co-financing the lease of recreational buildings, organising
sport events, and similar.
Investments in employee loyalty reduce the probability that an employee will quit working for the company due to disability, retirement or
similar reasons.
The remaining item to be defined is the annual depreciation rate of
investments into an employee. This rate may be obtained by dividing 
by the useful life of investments into an employee (expressed in years) as
shown below:
Annual depreciation rate of investments into an employee
=  / Useful life of investments into an employee (in years)
The useful life of investments into an employee is a period during
which the employee shall render services to the company as a result of
investments directed toward his/her employment. The duration of this
period depends on the intensity of knowledge obsolescence and varies
across employees. The knowledge obsolescence of employees with a technical education depends on the technical/technological development in
a particular economic area while the knowledge obsolescence of an employee graduating in the social sciences depends more on scientific development in that particular area and similar.
Net Carrying Amount. The net carrying amount of a tangible fixed
asset is the positive difference between its purchase value and its adjusted
value. It is a value that shall be transferred by a tangible fixed asset to
business effects during its remaining useful life.
Similarly, the net carrying amount of an employee depends on two
factors, namely:
• the previously determined positive difference between the purchase
value of an employee and his/her adjusted value and
• his/her significance to a company.
The value of an employee to a company depends on his/her position in
the company in terms of its organisational structure. Of course, this also
influences his/her remuneration. The wages and salaries of employees
are, therefore, important indicators of their value within the company.
Employee wages and salaries may be defined as a factor that reflects the
efficiency of the used work abilities of an individual in the company. An

Franko Milost
employee, with his/her presence in a business process offers the company a service and receives a salary in return. The salary amount reflects
the value of services offered by an individual to a company and also the
employee’s value to the company.
Accordingly, the net carrying amount of the value of an employee
must be corrected. The correction factor in this context is the ratio between the annual salary of an employee in a company and the average
annual salary of an employee in a national economy. The correction factor may be defined as follows:

Annual salary of an employee in a company
/ Average annual salary of an employee in a national economy
Evaluating a Group of Employees. The value of a group of employees
is not a simple sum of the values of individual employees – this value
usually differs from such a sum due to synergetic effects.
However, a certain relationship between the sum of values of individual employees and the value of a group of employees exists. We are of the
opinion that this relationship depends on the successful performance of
employees in the company compared to the successful performance of
employees in the entire economy.
The employees’ performance coefficient serves as a measure of the successful performance of employees. It is defined as the ratio between the
sum of weighted average added value per employee in a company and the
entire economy during the last three years (numerator) and the sum of
the number of years used (denominator). This ratio of last year is then
multiplied by a factor of , the ratio of two years ago by a factor of ,
and the ratio of three years ago by a factor of . The sum of the factors
(++) equals . Accordingly, the performance coefficient is calculated
as follows:

3  + 2 
 + 
Employees’ performance coefficient = 
6
Abbreviations in the equation mean:
 – added value per company employee during the last year
 – added value per employee in the entire economy during the
last year
 – added value per company employee two years ago
 – added value per employee in the entire economy two years ago
The remaining two abbreviations in the equation are defined by using
the same logic as above.
Evaluation of Intellectual Capital
When the value of a group of employees is to be determined, the aforementioned approach enables recognition of the overall performance of
a company for a period longer than one year. When calculating, the period selection is a matter of subjective judgement, however a three-year
period seems to be suitable. The business life of a company is rather intensive, and in the light of this, a three-year period seems long enough.
In addition, the overall performance of a company during the last year is
more accentuated than is the performance of previous years.

Employees are economic goods, and therefore we are of the opinion that
their value must be known. Knowing this value is crucial for obtaining
more realistic company financial statements and for anyone wishing to
manage human resources efficiently.

Flamholz, E. G. . Assessing the validity of a theory of human resource
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–.
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